Today the November employment report that was released and it amplified the talk of more aggressive fiscal stimulus for the US economy.
Before the almost record shattering numbers cam in the package was estimated to come in at about US$500B and would be enacted something in January 2009, and that it would include aid for state & local governments, expanded unemployment benefits, infrastructure investment, a “green jobs” program and some type of tax cuts for individuals.
Well, now the key people in Washington are saying that the package will be larger, and perhaps very much larger.
The structure of the stimulus package may be even more significant than the amount. You can bet that the political leaders now will not favor another program of tax rebate
checks such as the US tax payers recently experienced.
What would really be welcomed is a sizeable cut in payroll taxes. A six month suspension of the payroll tax beginning next year would inject US$400 to US$450B into the economy, and
provide discretionary spending support to those who are likey to spend while at the same time reducing the cost of labor for employers, which should help to slow the rapid job loss and shore up profitability.
In the US the federal government collects taxes from individuals and corporations. For individuals, there are two main types of taxes; income and payroll.
1. Income taxes are withheld from wages and since the amount of the tax is partially dependent on non-wage income and deductions, final settlements are made at the end of the tax year (note: some high income taxpayers are also subject to quarterly payments of tax).
Note: In Fiscal Year 2008, personal income tax payments collected by the Federal government totaled about US$1.1T
2. Next Individuals and companies are also subject to payroll taxes known as FICA. These taxes “purportedly”**fund the social security (i.e., retirement pensions) and Medicare (i.e., retiree health care) programs through a trust fund mechanism.
** “purportedly” because there is actually no dedicated financing for social security and Medicare and there are no private investments in the phantom trust funds, the truth is that the US government operates on a pay as you go system and all funds for government obligations come out of the same pot. So, a change in payroll taxes actually has no direct impact on the government’s ability to fund social security or Medicare benefits.
The payroll tax is based on a fixed percentage of an employee’s wages, with a matching payment coming from the employer. The social security component of the payroll taxes currently amounts to 6.2% for both the employee and employer (applied up to a maximum wage of US$107,000 in 2009) while the Medicare tax is 1.45% for each (with no cap). In 2008, payroll taxes totaled US$900B (in addition to social security and Medicare taxes, total payroll taxes include US$45B or so of unemployment insurance taxes paid by companies).
A reduction in the payroll tax always seems to be a favored stimulus option among economists when the US economy turns down.
In the current environment, a payroll tax cut has appeal for a lot of reasons.
Example: One is that it would help support the labor market through a reduction in the cost of labor while creating the right incentives for the unemployed. Another advantage is that lower wage workers, which tend to have a higher likelihood to spend, reap the greatest benefit.
Remember that an extension of unemployment benefits and financial aid for state & local governments, such measures do not really provide any net stimulative add-on for the economy, they just help to offset the potential negative consequences of inaction.
So, in the current sad state of the economy necessitates a significant push to the upside -
not just a cushion on the downside.
Few folks would argue with the idea that the US will achieve substantial long-run benefits from a well-orchestrated campaign of infrastructure investment, such spending
has a very long lead time and the economic impact would probably not be felt soon.
Infrastructure spending programs typically involve multiple layers of bureaucracy across the various levels of federal, state and local government, and this situation often will lead to what economists call “leakages” (layman speak: waste and fraud)..
Even so there would be ample room for all of these other forms of stimulus, in addition to the payroll tax cut, within a all encompassing stimulus package of US$750B or so.
The Big Q: If a cut in the payroll tax is such a great idea, why has it never been tried before
in the US?”
The Big A: politics. Why, because many politicians and special interest groups have helped to foster the misconception that a reduction in the payroll tax would represent a raid on the social security trust fund. Not true, Why because there is no trust fund in the conventional sense, there are only IOU’s that represent a claim on the Treasury’s general fund.
So, increasing or decreasing in payroll taxes has no fundamental impact on the US government’s ability to finance social security or Medicare.
Nevertheless, all past proposals to suspend the payroll tax have been doomed by politically motivated hype that caused fear and confusion in the general public.
Now can the incoming President Obama be the ideal leader to tackle these political hurdles?
If he can he should because a cut in the payroll tax represents a viable and effective policy option among the various forms of fiscal stimulus on the table now.
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